The Next Bear Market: How To Protect Your Assets

Make Portfolio Hay While The Sun Shines

While you have probably read countless bearish and inaccurate investing forecasts
over the past 24 months, the objective of this article is not to fearmonger,
but rather to cover some rational "that makes sense to me" concepts that may
help investors mitigate, not eliminate, portfolio risk in the next inevitable
bear market. Yes, inevitable; it not a question of if a bear market is coming,
but when. The only question is will you be ready when the bear pays a visit
sometime in the next few years? For the record, based on what we know as of
the writing, the present day climate does not align with an imminent bear market.

Markets Are Harder Than Weather

We respect the high degree of complexity found in various weather systems.
While the heading above is debatable, if you consider the following, we believe
it is not even a close call...markets are much more complex than weather:

Asset prices are impacted by the decisions of billions of people around
the globe.

Geopolitical events can seemingly "come out of nowhere"; something we recently
experienced with Iraq.

Markets are impacted by earnings, interest rates, health of the banking
system, regulations, political events,...and even the weather.

Weather Forecasting Difficult After Day 8

If we believe economic and market forecasting is more challenging than weather
forecasting, then a logical question to ask is how far into the future can
professional meteorologists add value with their forecasting models? For the
answer, we turn to a segment from Nate Silver's book, The Signal
And The Noise - Why So Many Predictions Fail:

"But the further out in time these models go, the less accurate they
turn out to be. Weather forecasts made eight days in advance demonstrate
almost no skill. And at intervals of nine or more days in advance, the
forecasts were actually a bit worse than climatology."

If we cannot add value with a 10-day weather forecast, then how prudent is
it to allocate your investments based on annual forecasts and predictions from
Wall Street experts?

If Weather Forecasts Are Not...Then Market Forecasts...

If weather forecasts are not particularly useful looking out just eight days
into the future then how accurate is an economic or market forecast that looks
even just several months down the road? Again, the answer is debatable, but
if we believe markets are harder than weather, and weather forecasts are not
all that useful when you hit day eight, then we can surmise that stock market
forecasts looking out more than eight days are probably not particularly helpful
or useful. If you want a real world example of financial market forecasting,
see the track record for professional forecasts presented in The Most
Important Thing For 2014.

Is There A Better Way? Navigating In 2008

Financial markets are difficult regardless of which approach you use. The
previous sentence applies to any probabilistic model, including our market
model. However, if you watch the video below focusing on "monitoring and adjusting" rather
than "forecasting and hoping", you will probably agree that there are some
logical things investors can do to improvement their odds of success. In terms
of the video, the simple method presented illustrates concepts that can mitigate,
not eliminate, investment risk during the next bear market in stocks.

How does the "2008 look" shown in the video compare to the present day? The
present day looks much, much better, telling us the aggregate interpretation
of all the fundamentals (earnings, Fed policy, geopolitical events, valuations,
etc) remains positive and bullish for stocks. As long as the chart below maintains
its current look, the odds will be favorable for equity investors.

How Do Fundamentals Come Into Play?

The video above uses charts to monitor the market's pricing mechanism. Does
that mean fundamentals don't matter? No...fundamentals are behind every move
in any asset market. Charts are one of many methods to monitor the aggregate
interpretation of all the fundamentals, including earnings, valuations, the
Fed, and even the impact of the difficult-to-forecast weather. As of June 20,
2014, our market model tells us the aggregate interpretation of the fundamentals
remains constructive for stocks. From Zacks
Investment Research:

With not much on the economic calendar, stocks today will likely reflect
the positive momentum generated by Wednesday's Fed meeting... The Fed's
dovish commitment is a very powerful elixir for this market, trumping any
other catalyst on the horizon. And we don't have much in terms of economic
or corporate earnings catalysts over the next couple of weeks anyway. On
the economic docket next week are a couple of housing reports and another
look at the Q1 GDP read. The GDP report is essentially record keeping at
this stage, with the greater negative revision to the Q1 growth pace unlikely
to weigh on investors' outlook for the current and coming quarters. Data
for the current quarter has been consistently positive enough that GDP
growth estimates remain north of 3%, with some of the more aggressively
optimistic estimates above the +4% level.

Investment Implications - Odds Still Favor Stocks

How do we use all this? Our approach is to meticulously monitor the market's
tolerance for risk, then allocate our portfolios in line with the evidence
we have in hand, rather than making any assumptions about what tomorrow looks
like. From there, monitor again and adjust if needed...rinse and repeat.

The stock market's risk profile has been improving fairly steadily since April
11. Consequently, our market model has allowed us to incrementally increase
our equity allocation (SPY) over the past 15 weeks. Over that period, we have
reduced our bond exposure (TLT) twice to stay in line with the improving climate.
We continue to maintain exposure to leading sectors, such as transportation
(IYT).

Financial Forecasting Paired With Portfolio Flexibility

Most stock market forecasts are not particularly helpful, but there are a
small percentage of probabilistic models that add value from a risk management
perspective. We are not fans of forecasting, but our market model, like others,
produces short-term probabilistic forecasts based on observable evidence. The
same can be said for many market and economic models. The key is to update
your forecast as the inputs change and to remain flexible enough to adjust
your portfolio when the model calls for it. Our approach is one of many that
can add value. One of the greatest things about the financial markets is there
are countless ways to skin the risk management cat.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
investment objectives and financial position. Past performance is not necessarily
a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
the interest of investors. All prices and yields contained in this report are
subject to change without notice. This information is based on hypothetical
assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES,
EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM
ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.